Fitch Downgrades Cape Verde to 'B'; Outlook Stable

Fri Mar 21, 2014 1:03am EDT

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: Cape Verde - Rating Action Report here LONDON, March 21 (Fitch) Fitch Ratings has downgraded Cape Verde's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'B' from 'B+'. The Outlooks are Stable. The Short-term rating has been affirmed at 'B' and the Country Ceiling downgraded to 'B+' from 'BB-'. KEY RATING DRIVERS The downgrade of Cape Verde's IDRs reflects the following key rating drivers and their relative weights: High Public debt will rise faster and peak much higher than previously forecast, increasing the risk to debt sustainability. Fitch expects the general government debt ratio (GGGD) to rise to over 115% of GDP by 2015, more than 10 percentage points higher than our November projections. It will peak above 120% around 2017 on weaker growth and wider fiscal deficits. Although much of the debt is concessional from bilateral and multilateral lenders, and is to finance improved infrastructure, the impact on future growth is uncertain and the interest burden is rising alongside GGGD. Fitch estimates that GGGD has already increased by more than 40pp since 2008. The government has overshot original fiscal targets in recent years. This trend is likely to continue. In Fitch's view, the 2014 budget is based on over-optimistic growth assumptions for the medium term. Furthermore, the effective consolidation of government expenditure is constrained by a high share of mandatory spending. On-lending to public enterprises by the government also adds to funding needs, further elevating public debt (the authorities have budgeted an additional 16% of GDP of on-lending up to 2017). The economy has been significantly underperforming and growth will remain weak in the near term. GDP has come close to stagnating in 2013 due to weak domestic demand, falling remittances and weak foreign direct investment. Tourism receipts, which account for about one-fifth of the economy, are still increasing. Fitch expects growth to have eased to around 1% from a revised 1.5% in 2012. Fitch has revised down its near-term growth and inflation outlook, leading to a sizeable worsening of public debt dynamics from previous projections and significantly increasing the challenge to the government to consolidate public accounts. There are still uncertainties around historical GDP growth numbers as national accounts are updated only up to 2011, although 2012 data is expected to be released soon. Fitch estimates Cape Verde's average growth for the past five years to be 1.3%, which is weak compared with the 4.2% 'B' median, and volatility has also been higher. In the decade up to 2008, the economy grew by an average of 7% per annum. The underlying state of the sovereign's external finances is weak and will likely worsen, increasing the vulnerability of the economy to external shocks. Net external debt is significantly higher than both the 'B' and 'BB' rating medians. With the bulk of the government's borrowing coming from outside Cape Verde, external finances will be worse than previously projected given the weaker public debt dynamics. Nevertheless the recent increase in foreign exchange reserves to over four months of imports should help offset some of the risks from rising external debt, at least in the near term. External borrowing is also mostly on concessional terms. The Stable Outlook reflects the following key rating drivers: Governance indicators are strong compared with the 'B' median. Well-functioning political institutions provide support to the macroeconomic and business environment. Cape Verde scores relatively high in the World Bank indicators for control of corruption, rule of law, effective government and voice and accountability. Sustained implementation of the government's current Growth and Poverty Reduction Strategy (GPRSP III) should help Cape Verde foster private sector development by addressing the country's critical infrastructure needs, albeit at the cost of deteriorating public finances. Cape Verde's external debt servicing cost is significantly below rating peers. As a share of foreign exchange receipts we estimate it comes to 4% for 2013 and compares with 7.5% for the 'B' median and 12.2% for the 'BB' median. This reflects the high proportion of concessional debt. The average maturity of government's debt stock is more than 20 years and the average interest rate is low. The long-established pegged currency provides an anchor for macroeconomic stability, limiting exchange-rate risk for international transactions and supports emigrant savings to the economy. The pegged exchange rate regime has helped to also contain inflation. The five-year average and long-term volatility in consumer prices are below the 'B' and 'BB' medians. RATING SENSITIVITIES The Stable Outlook also reflects Fitch's assessment that upside and downside risks to the rating are currently well balanced. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. The main factors that, individually or collectively, could lead to positive rating action are: - Evidence of public investment projects translating into higher economic growth and broad development of private sector activity which boosts confidence in medium-term growth prospects. - Materially better than expected fiscal performance that provides greater confidence in delivering a sustained downward trajectory in the public debt-to-GDP ratio in the medium term. The main factors that, individually or collectively, could lead to negative rating action are: -Public finances materially worse than expected under the new Fitch baseline projections. - Weaker than expected medium-term growth potential that adds to pressure on the government debt-to GDP ratio. This includes the failure of the ongoing capital investment programme to improve infrastructure to support faster sustained medium-term growth. KEYASSUMPTIONS Fitch assumes that the sovereign's public investment projects will continue so long as concessional financing is available, although we expect that with Cape Verde's eventual accession to middle income status, concessional financing will gradually taper off. Fitch assumes the currency peg to the euro and support for the system from the Portuguese government will continue. Due to a degree of dependency on eurozone developments, Fitch's macroeconomic forecasts for Cape Verde are premised on the nascent eurozone recovery staying on track. Contact: Primary Analyst Enam Ahmed Director +44 20 3530 1624 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Kit Ling Yeung Analyst +44 20 3530 1527 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email:; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:; Hannah Huntly, London, Tel: +44 20 3530 1153, Email: Additional information is available on Applicable criteria, 'Sovereign Rating Criteria' dated 13 August 2012 and 'Country Ceilings' dated 09 August 2013, are available at Applicable Criteria and Related Research: Sovereign Rating Criteria here Country Ceilings here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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